Indian Bonds Tumble After Surprise Rate Hike

Raghuram Rajan at a press conference at the RBI headquarters in Mumbai, Sept. 4.

Indian government bonds have been hammered after Friday’s unexpected interest-rate hike by the central bank, and investors are now preparing for more rate increases.

The yield on the benchmark 10-year government bond rose by 0.65 percentage point–a sharp move in the bond world–over the past three trading sessions through Tuesday. Yields move inversely to prices.

This has been a particularly volatile year for Indian government bonds, as expectations for interest-rate movements have fluctuated wildly as the country faced an economic slowdown, high inflation and a sharp decline in the value of its currency.

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The Reserve Bank of India cut rates earlier in the year to boost growth. But the rupee’s tumble during the summer put an end to the cuts.

Investors had hoped the Reserve Bank of India would hold the benchmark interest rate steady at its policy meeting on Friday. They felt upbeat because the U.S. Federal Reserve had just announced that it would delay winding down its monetary stimulus program, which had been a source of funds for emerging markets. The yield on the 10-year Indian government bond ended Thursday’s session at 8.19%.

But newly appointed RBI Governor Raghuram Rajan raised the benchmark interest rate by a quarter percentage point to 7.50%, saying the move was necessary to keep inflation in check. It was the first rate hike in two years.

On Monday, bond yields spiked to 8.90%, a level last seen on Aug. 28, the day the rupee touched an all-time low of 68.80 to the U.S. dollar. The yield on the 10-year bond closed at 8.84% on Tuesday.

“The readjustment in the market has been sharp,” said Mahendra Kumar Jajoo, head of fixed income at Mumbai-based Pramerica Asset Managers.

Given India’s stubbornly high inflation, investors are now bracing for further rate increases in the coming months. India’s wholesale inflation accelerated more than anticipated in August as food and fuel prices rose. “We expect bond yields to stabilize around the 8.70%-8.90% level as we await fresh data inputs on inflation,” said Shakti Satapathy, fixed-income analyst with Mumbai brokerage A. K. Capital.

Investors are also tracking the Indian federal government’s borrowing calendar. The government has said it plans to raise 2.35 trillion rupees (US$37.5 billion) by selling bonds between October and March. However, if it ends up selling more than planned, the greater supply would push prices lower.

Some analysts worry that higher global oil prices would increase the government’s import bill. “There is an outside chance they may have to borrow more to meet the higher fuel-subsidy bill, which will be negative for the bonds,” Mr. Satapathy said.

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